Amplification of Uncertainty in Illiquid Markets

Albagli, Elías

doi:10.2139/ssrn.1788216

Cited by 19 publications

(16 citation statements)

References 49 publications

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“…6 One conclusion from this literature is that the sensitivity of capital investment with respect to stock prices is low or that the stock market is a "sideshow" with respect to the real economy (Morck, Shleifer, and Vishny, 1990). By contrast, we show quantitatively that the social cost of a failure of information aggregation, transmitting itself through the channels outlined investment opportunities, and Albagli (2011), where noise trader risk is amplified due to liquidity constraints on traders.…”

Section: Related Literaturementioning

confidence: 72%

The Social Cost of Near-Rational Investment

Hassan

Mertens

2017

American Economic Review

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We show that the stock market may fail to aggregate information even if it appears to be efficient, and that the resulting decrease in the information content of prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors when forming expectations about future productivity. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When prices reflect less information, the conditional variance of stock returns rises, causing an increase in uncertainty and costly distortions in consumption, capital accumulation, and labor supply. (JEL D14, D83, D84, E21, E22, E24, G14)

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Section: Related Literaturementioning

confidence: 72%

The Social Cost of Near-Rational Investment

Hassan

Mertens

2017

American Economic Review

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“…Regarding multiplicity, a finite investment horizon economy generically exhibits two equilibria (whenever equilibria exists), a result consistent with the findings of Spiegel (1998) and Watanabe (2008) for 2-period OLG economies. 1 These include a stable, low volatility equilibrium where innovation in the asset supply have small price impact, and an unstable equilibrium where they cause high volatility in returns. In this respect, the contribution of the present paper is describing the evolution of pricing moments along these equilibria as a function of the investment horizon.…”

Section: Introductionmentioning

confidence: 99%

“…Cespa and Vives (2012) focus on how persistent noise trading can generate two equilibria even in a finite horizon economy. Also, in an earlier version of this paper, I study the impact of increased fund liquidations during downturns in effectively lowering investors' horizon, and its implications for price informativeness and expected returns (Albagli, 2009). It is of course difficult to compare the results obtained in a fully dynamic model from those derived from finite horizon environments.…”

Section: Introductionmentioning

confidence: 99%

Investment Horizons and Asset Prices Under Asymmetric Information

Albagli

2012

SSRN Journal

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I study a fully dynamic rational expectations economy with asymmetric information, where agents have finite investment horizons; T. Horizons affects asset prices through two key mechanisms: as T increases, 1) the age-adjusted risk aversion of the average investor falls, and 2) the risk transfer from forced liquidators into voluntary buyers drops. There are typically two equilibria: a stable equilibrium in which higher T lowers price volatility, and an unstable one with the opposite properties. Moreover, equilibria that fail to exist for low T can be recovered for high enough lifespan. Along the stable equilibrium, increasing T lowers price volatility and alleviates the uncertainty of uninformed investors. The low risk environment induces aggressive trading by the informed, which impound their knowledge into prices. Expected returns and return volatility are similar to an economy with full-information about fundamentals, even if the informed are relatively few. For short horizons, cautious trading disaggregates information from prices and the economy approaches one with no private information. Consistent with evidence of increased fund liquidations during episodes of financial distress, the results suggest that heightened volatility and uncertainty can be explained by the shortening of investor horizons in a rational economy with asymmetric information. JEL codes: E23, E32, G12, G14, G23.

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“…Our results are related to—and have implications for—three strands of the literature. First, our paper is related to the literature on the relationship between the effect of short‐term investment horizons on prices and the reaction of investors to their private signals (see Singleton (), Brown and Jennings (), Froot, Scharfstein, and Stein (), Dow and Gorton (), Vives (, ), Cespa (), and Albagli ()). If prices are semistrong efficient (as in Vives ()), then traders do not require compensation for increasing their exposure to the asset and so the inventory component of the price impact disappears.…”

Section: Related Literaturementioning

confidence: 99%

The Beauty Contest and Short‐Term Trading

Cespa¹,

Vives

2015

The Journal of Finance

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Short-termism need not breed informational price inefficiency even when generating Beauty Contests. We demonstrate this claim in a two-period market with persistent liquidity trading and risk-averse, privately informed, short-term investors and find that prices reflect average expectations about fundamentals and liquidity trading. Informed investors engage in "retrospective" learning to reassess inferences (about fundamentals) made during the trading game's early stages. This behavior introduces strategic complementarities in the use of information and can yield two stable equilibria that can be ranked in terms of liquidity, volatility, and informational efficiency. We derive implications that explain market anomalies as well as empirical regularities.

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Amplification of Uncertainty in Illiquid Markets

Cited by 19 publications

References 49 publications

The Social Cost of Near-Rational Investment

The Social Cost of Near-Rational Investment

Investment Horizons and Asset Prices Under Asymmetric Information

The Beauty Contest and Short‐Term Trading

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